I can’t even tell you how many emails and I’ve received over the last few weeks talking about the downturn in the stock market. People are worried about their retirement savings, about their down payment savings, about everything. “What should I do?”
I touched on this a little bit in Monday’s reader mailbag. Here’s a question from a reader and my answer to it, which is pretty relevant right now.
Maybe it is just my personal mindset but I don’t understand why people get really panicked when the stock market drops a little. It’s not as if America is on the verge of collapse any time soon. The value will come back. I mean, I understand why the market drops a little sometimes – people buy in too much and then decide to sell because of some bad news or something. What I don’t understand is the fear and panic that goes on when it happens?
For starters, some people have a lower risk tolerance than others. When they see the value of their investment jumping around like that, they get nervous and want their money to be somewhere that doesn’t jump around like that.
For others, they buy completely into the panicked tone that some financial writers get into when the stock market gets jittery. If you read mainstream financial news online right now, much of the talk seems very panicked and scary, as it always does when the stock market drops a little. Some really buy into this and whip themselves into frenzied fear.
Still others are really risky investors and speculators who are doing things like buying derivatives and selling things short. A poorly timed market drop can be extremely painful for someone who is leveraged like this – like “lose all of your money in a few days” kind of painful – though a person in that situation can make a lot of money very quickly if things go well.
If you add those factors together, it becomes clear why the fear factor exists. It just doesn’t add up to enough for most people to really do anything with their money. Just stay the course. Eventually, the market drops enough that everything appears to be on sale.
While I think this is a great answer as to why different people are panicked about the current stock market downturn (I actually think the “Panic!” tone of CNBC and the financial media is a big cause), it doesn’t really explain why I’m personally not worried and why, frankly, I don’t even really pay any attention to downturns like this.
First and foremost, I don’t read the financial “news.” I don’t watch CNBC at all. I don’t read current financial publications, or if I do, I skip the majority of the articles.
Why do I do that? Doesn’t that run counter to the idea that I’m a personal finance writer? Shouldn’t I be up to date?
The truth is that all of that stuff that I skip has an extremely short-term focus and I don’t have a short-term focus at all. I am not a day trader. I have zero interest in being a day trader. I have zero plans to touch any of my investments for a very long time.
What I do read are books on personal finance and investing. Books tend to have a long-term perspective on investing and personal finance. They also have the space to make a reasoned argument and, because they’re written over time, they’re not nearly as prone to be influenced by the ups and downs of the stock market. Of course, some books do fall prey to speculation, but those books are pretty obviously flawed.
I trust books like The Bogleheads Guide to Investing by LeBoeuf, Lindauer, and Larimore. Books like The Four Pillars of Investing by William Bernstein, or Your Money or Your Life by Joe Dominguez and Vicki Robin. Those books take a very long-term perspective, a whole-life perspective when it comes to personal finance — something sorely missing in much of personal finance media.
After all, I’m more concerned with what my investments and finances will be like when I’m 70 than what they’re going to be like next month, because I’ve worked hard to build a life foundation that makes me very sure that things will be quite stable a month from now.
Still, shouldn’t a big downturn in the stock market alarm me? Just like everyone else, I’ve lost about 9% of the value of my stock market investments since the start of the year. Doesn’t that freak me out?
Again, not really.
The key thing to remember is that at this point in my life, I’m in the wealth accumulation phase. I’m saving up so that I can eventually live off of my investments, but I’m not there yet. I don’t need to live off of those investments yet.
So, the truth is that I see these kinds of short downturns as an opportunity. Right now, I can buy a share of Vanguard Total Stock Market Index for 9% less than what I would have paid for it three weeks ago. Since my focus isn’t on the return I’ll get this year or next year or even 10 years from now, all that I can really be confident about is the price at which I’m buying right now.
All of my investments will essentially be sold at some vague point far down the road, so all I care about is that, right now, I can buy a share of that index fund for 9% less than what I could pay three weeks ago. That’s a sale, one I’m tempted to take advantage of. I actually want to put in more money rather than put in less or take money out.
For me, it’s similar to the feeling I get when I see something on sale two weeks after I bought it at a higher price. I don’t worry that the world is collapsing. Instead, I wish I had been able to buy it at this price. Just like buying something at the store, I’m not focused on making a profit by selling it in a month or two. I’m interested in the fact that I’m getting more value for my dollar at the sale price.
Think about it: The only time you should really be happy that stock values are going up is if you’re planning on selling soon. Otherwise, it doesn’t matter to you – if anything, it’s a downer because it means that if you’re buying more soon, you’re going to be paying more for it.
The reverse is true when prices are going down – you should only be sad about it if you’re going to be selling soon, and if you’re going to buy soon you should be thrilled about the downturn because you’re going to save some money or get more shares for your dollar.
But what about those people who are already retired and living at least in part off of their investments? Shouldn’t they be panicking?
They might have a little more reason to be nervous, but even then, they shouldn’t care that much. If the stock market downturn is making them nervous, that means they have too much invested in the stock market. If they can’t “retire” without having that much in the stock market, then they retired too early and without proper planning. It’s a sign that they may have to return to work, not that they should make panicked moves with their investments. (Seriously, the worst thing you can do is make an investment change in a broad way because of short-term trends in the stock market.)
The truth is that even retired people shouldn’t be invested in stocks unless they’re in it for the long haul.
To sum it all up, for most people who aren’t on Wall Street or involved in day trading, the stock market should be a long-term investment, period.
Stocks as an investment have relatively steady growth only when you’re looking at relatively large time periods, like 15 or 20 or 30 years. Over shorter time periods, it’s volatile – it’ll go up 15% a year for a while, then drop 30% in a year. It will have months where it goes up 3%, then up 4%, and then drop 9%. That kind of volatility only becomes relatively steady if you step back and zoom out from the charts, at which point stock markets in stable countries show a pretty steady upward growth trend over time. That’s because those markets represent capitalism, innovation, and increases in worker productivity when you look at the long term. Over the short term, you’re looking at a big mix of things, positive and negative.
I’ve always liked Burton Malkiel’s “random walk” explanation for this. Say you have a guy walking up and down a sidewalk who’s predisposed to take a step forward 55% of the time and a step backward 45% of the time and he does them completely at random. Over the long haul – a lot of steps – that guy’s going to make significant progress down the sidewalk. But if you zoom in and look at small groups of steps, there are going to be periods where he looks like he’s headed purely in the wrong direction.
That’s where we’re at now – the stock market is a “random walker” and we’re seeing a short-term trend of backwards steps from it.
However, since I’m looking at the long term, I honestly don’t really care all that much. In fact, the only comment Sarah or I have made about it is to joke about how much we’ve lost on paper in the last month, but we both laugh the whole thing off because we know we’re in it for the long term.